Last month, we started talking about asset protection. We discussed what it is, why it’s necessary to protect ourselves in our country, and how having multiple layers of defense is the best approach. I explained umbrella insurance, Limited Liability Companies (LLCs), and the difference between “Inside” and “Outside” liabilities. We saw how LLCs can protect your other assets (which are not owned by the LLC) against inside liabilities, but it doesn’t protect your assets against outside liabilities. An LLC also doesn’t protect your assets inside the LLC from inside liabilities. (I know this is a bit complicated to explain all in two articles, so if you’re concerned about Asset Protection, please see us or another competent attorney on how to apply these principles to your situation).

A few more asset protection strategies that can be implemented are: (i) Owning assets as Tenants by the Entirety; (ii) Asset Protection Trusts; and (ii) Equity Stripping. We have touched on some of these topics in past articles, but I’ll explain again today the basics of each and how they relate to inside and outside liabilities.

“Tenants by the entirety” is a way of holding title to assets that used to be available only to husbands and wives. Now that we have civil unions and reciprocal beneficiaries in Hawaii, unmarried couples (whether same-sex or opposite sex) who meet the requirements and have a civil union performed, or have a reciprocal beneficiary relationship registered, are also eligible to own property as tenants by the entirety. As of last summer, eligible couples (married, civil union or reciprocal beneficiaries) can also transfer their real property into separate revocable trusts and maintain tenants by the entirety protection. Tenants by the entirety ownership protects the property from the creditors of one of the couple. In order for a creditor to go after property owned as tenants by the entirety, the creditor must have a judgment against both husband and wife (or both members of the civil union or reciprocal beneficiary relationship). This can protect that parcel of real property from being lost to an outside liability of one of the couple. However, it doesn’t protect the property from being lost to inside liability stemming from that property because both of the tenants-by-the-entirety owners would be subject to any law suits based on their ownership of that property. For example, if a tenant slipped and got hurt, he could sue both the couple as owners and they would both be liable.

An Asset Protection Trust is a trust which you create and into which you transfer your assets, and generally, you are the beneficiary of this trust. Hawaii is one of only 13 States that allow a person to set up an Asset Protection Trust for her own benefit and protect those assets against creditors. If it is set up correctly, any assets transferred to that trust will be protected from your creditors once two years have passed from the date you transferred that asset into the Asset Protection Trust. An asset protection trust protects the assets held within the trust from your personal (outside) liabilities. You may have your asset protection trust own an LLC that owns rental property which also separates that rental property’s liability (inside) from the other assets held within the trust. However, assets transferred to an Asset Protection Trust are not protected from your Nursing Home costs if you are a beneficiary of that trust.

Finally, Equity Stripping is a technique that removes the equity from your properties or business entities so that even if the entity is sued, there is nothing for the creditor to collect. The way we do this is by having a mortgage placed on the property for the entire value of the property, but instead of getting a mortgage from the bank, you can have the mortgage issued by yourself, one of your business entities or a friendly party (such as a family member).

One way we can use all of these techniques together is to set up an Asset Protection Trust which will own an LLC which will own your rental property. The LLC can be subject to a mortgage from your Asset Protection Trust for the value of your rental property, removing any equity from the property and the LLC. After two years, if anyone sues you (outside liability), your assets are protected within the asset protection trust. If anyone gets injured on your rental property and sues the owner/LLC, they might win a judgment for their injuries, but the LLC protects the other trust assets from this judgment (inside liability), and even though the creditor would normally be able to take the equity value of the rental property owned by the LLC, with the equity stripping strategy in place, your Asset Protection Trust would be able to collect on its mortgage before the creditor could ever get paid so there is no value for the creditor to take out of the LLC or the rental property.

Asset Protection is a complicated area of the law with many pitfalls if it’s not done correctly. However, with more and more lawsuits and divorces happening, it’s very important to plan to protect your assets against these risks ahead of time. Be sure to get expert advice in how to best structure your estate to protect your hard-earned assets!

“Equity Stripping is a technique that removes the equity from your properties or business entities so that even if the entity is sued, there is nothing for the creditor to collect. The way we do this is by having a mortgage placed on the property for the entire value of the property, but instead of getting a mortgage from the bank, you can have the mortgage issued by yourself, one of your business entities or a friendly party (such as a family member).”

You’re right, this is a very difficult concept–as is most of estate planning when it comes right down to it. I think the easiest way to make it understandable is to use an actual example from the client’s specific situation. If you have a business or rental property, it might make sense to have the business or property owned by an LLC (or other type of liability limiting entity) and strip the equity from the business or asset. Call our office to set up a consultation and we can go through whether this strategy might be appropriate for you, and how exactly to implement it in your case. Thanks for reading!

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